Everyone wants to buy into a big yield. The trouble is most people aren’t willing to put in the time to tell the good from the bad and ugly. No matter what high-yielding investment you own, knowing the health of its underlying business is critical. You should always sell if the underlying business of your stock deteriorates.

Roger Conrad – Big Yield Hunting

A high-yielding stock isn’t any good if the yield is unsustainable.  There’s nothing worse than investing in a stock expecting a certain level of dividend income to meet living expenses, only to see that income cut out from under you. As I wrote back in September, there are several financial warning signs investors should look out for to avoid such dividend time bombs.  One of the warning signs mentioned in that article was a recent dividend cut. If a dividend cut signals financial distress, it makes sense that this financial distress could cause a second round of dividend cutting. 

The corollary of dividend cuts acting as a negative signal of future financial distress (and additional dividend cuts) is the idea that dividend raises act as a positive signal of future financial success, which will result in stocks that have recently raised their dividends raising them again, or at least not cutting their dividends anytime soon. 

Dividend Research Doesn’t Lie

Does the academic research support the theory of current dividend changes signaling future corporate performance? For dividend raisers, the answer is yes.  A 1997 study found that:

firms that increase dividends are less likely than non-changing firms to experience a drop in future earnings. Thus, their increase in concurrent earnings can be said to be somewhat “permanent.” Firms that increase dividends have significant (though modest) positive excess returns for the following three years

A more recent 2008 study concluded:

We find that increases in payout ratios predict significantly higher future earnings over all time periods. This provides support that higher payout ratios signal higher future earnings.

For dividend cutters, the evidence is inconclusive. On average, earnings in the year after a dividend cut actually rise, but this rise may be from such a low level that further dividend cuts are still needed.

Recent Dividend Raisers and Cutters

Whatever the case, I thought I would take a look at some companies that have recently raised and cut their dividends and see how their performance subsequent to the dividend announcement has performed relative to the S&P 500. The results are below:

 Dividend Raisers

Source: Bloomberg

Dividend Cutters

Source: Bloomberg

With the exception of apartment REIT Home Properties, the dividend raisers have all outperformed and the dividend cutters have all underperformed. Pretty impressive!

Big Yield Hunting

Even more impressive is the stock-picking ability of Roger Conrad and David Dittman, co-editors of Big Yield Hunting, KCI’s new high-yield investment service. Each month, Roger and David present a new high-yield stock idea that they have fully vetted and whose dividend is sustainable. In many cases, the dividend is not only double-digit, but has recently been raised. Give Big Yield Hunting a try today!